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December 12, 2012

Fed Announces QE4, With a Twist

QE Whatever is now officially QE4, but with an unexpected twist: Fed will hold rates steady and continue to buy until unemployment hits 6.5% and inflation remains tamed.

The Federal Reserve announced Wednesday it would repurchase $85 billion in bonds each month for the foreseeable future. The announcement, following the two-day meeting of the Fed's Open Market Committee (FOMC) was in line with economists’ predictions that the new policy would push the Fed’s balance sheet to almost $4 trillion.

The twist is that the future of any easing will be set to the level of the unemployment rate and the inflation rate rather than a specified period of time.

The Fed held the federal funds rates steady at between at 0% and 0.25%, saying it would peg that rate and its bond buying programs to a specific unemployment rate and inflation rate. The Fed said rates would remain at that low level for “at least as long as the unemployment rate remains above 6.5%, inflation between one and two years ahead is projected to be no more than a 0.5% point above the Committee's 2% longer-run goal and longer-term inflation expectations continue to be well anchored.”

Moreover, to support a "stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate," the FOMC statement released Wednesday said it would "continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month.”

The Fed said it would also purchase longer-term Treasury securities, initially at a pace of $45 billion per month, for a total of the aforementioned $85 billion.

“I’m surprised the Fed tied itself to a specific unemployment number,” said advisor Gary Shilling, president of A. Gary Shilling & Co. “It’s such a squishy number. There might by those that are answering the monthly survey that have dropped out of the workforce or are underemployed.”

If the outlook for the labor market does not “improve substantially,” the Fed said it will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, “until such improvement is achieved in a context of price stability.”

“What the Fed is saying is ‘damn the balance sheet, full steam ahead,’ Shilling added. “It’s Operation Twist, but a little different. They’re essentially extending their buying on the long end of the curve, but now they’re forgetting about the short end, because they feel it just isn’t worth it and won’t affect rates.”

“To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens,” it concluded.